There are contradictory schools of thought in the financial world as to whether moving money to and from retirement accounts is considered a rollover or transfer.
When done correctly, there shouldn’t be any taxable consequences to a direct rollover or a direct transfer. In today’s post, we’ll cover the different types of rollovers and transfers, as well as how different financial schools define a rollover and a transfer.
One idea is that a transfer consists of moving money between two of the same types of retirement account, e.g. Traditional IRA to Traditional IRA. Whereas, if you are moving funds between two distinct types of retirement accounts, that would be a rollover.
You might do a rollover from:
a traditional IRA to your new Solo 401(k)
Thrift Savings Plan to your Solo 401(k)
457 plan to your IRA
SEP IRA to your Solo 401(k)
403(b) to your Solo 401(k)
Whereas a transfer would include:
one IRA to another IRA
Roth 401k to your Roth Solo 401(k)
previous employe 401(k) to your new Solo 401(k)
one Roth IRA to another Roth IRA
Another school of thought determines if moving funds is a rollover or transfer based on which party initiates the movement of funds.
For example, if you (as the accountholder) initiate moving funds, it would be a rollover. Rollovers generally include moving money from an employer sponsored plan, such as a 401(k), 403(b), 457 plan, Thrift Savings Plan (TSP), pension plan, etc to an IRA or new employer-sponsored plan, such as a Solo 401k. These would be considered rollovers, because you are initiating the movement of money.
For example, if you set up your Solo 401k with Nabers Group, you would initiate your rollover from a previous employer 401(k) plan so that the funds arrive into your Solo 401k plan. Similarly, you might initiate the rollover from an old IRA so that the funds arrive in your Solo 401k plan.
A transfer, on the other hand, is initiated by an outside party, such as an IRA custodian. In other words, the new custodian sends the request to the resigning custodian.
While “rollover” is the general term used to move money from one retirement account to another, sometimes the rollover isn’t a rollover, but a transfer.
Further, there are distinct types of rollovers and transfers.
There are two types of rollovers you might initiate into your Solo 401k plan, a direct rollover or an indirect rollover. These two types of rollovers have very different tax implications, so proceed with caution!
Direct rollover: your funds are moved directly from one retirement plan to another. There is no taxable withholding and you don’t have to pay any taxes or (early withdrawal) penalties for moving the money from one retirement plan to the next.
Indirect rollover: also known as a 60-day rollover, this occurs when your funds indirectly make their way into your retirement account by going through you first. Generally, your custodian or plan administrator will send a check with your retirement funds made payable to you personally. You then have 60-days to deposit those funds into your retirement plan. If your funds are not deposited within 60-days, the funds may be considered to be taxably distributed (and potentially have early withdrawal penalties as well if applicable).
In the world of “transfers”, a direct rollover might also be called a trustee-to-trustee transfer. This is another way of saying the funds are moving directly from one retirement plan to another.
Generally, direct rollovers and trustee-to-trustee transfers are fairly straightforward. With an IRA, your custodian will request the funds from your previous IRA custodian, get the money and deposit it into your new IRA.
With a Solo 401k, the Nabers Group 401k software will prepare customized direct rollover documents to request the funds be sent directly into your new Solo 401k trust avoiding taxable distributions. The rollover check will be made payable to your new Solo 401k trust and you’ll deposit the check in a bank or brokerage account also titled in the name of your 401k trust. This way, the funds go directly from one retirement account to another.
If you are doing an indirect rollover, taxes may be withheld – 10% for an IRA and up to 20% for a 401k. This is called a rollover distribution. The funds are held back in case you don’t deposit the rollover funds in time. The funds held back are there to cover taxes you might owe on those distributed funds. A rollover distribution is generally considered part of your taxable income.
If you take an indirect rollover, make sure you deposit the check into a new qualified retirement plan (Solo 401k or IRA) within 60-days to avoid a taxable distribution. Additionally, the amount you deposit into your retirement account must exactly equal the amount you received in your initial indirect rollover check.
We don’t generally recommend you do an indirect rollover when transferring funds into your new self-directed retirement account. Be it a new self-directed IRA LLC, or a Solo 401k – there are often paths you can take so the funds are directly rolled over or transferred, thus avoiding the potential for a taxable distribution or early withdrawal penalties.
Reporting a Direct Rollover
Rollovers are generally reported on IRS form 1099-R. If you have a Solo 401k with Nabers Group, we’ll provide you a sample 1099-R to share with your current custodian or plan administrator to help them complete and document your direct rollover correctly.
Direct rollovers will have $0.00 in box 2a, and distribution code G in box 7. This will tell the IRS the funds were directly rolled over or transferred from one retirement plan to another and that no taxes are owed.
If your IRA custodian does a direct rollover to another IRA or your Solo 401k, you might not receive a copy of the 1099-R at all. You might request a copy of the 1099-R for your records, to ensure the direct rollover was documented correctly.
If you’ve completed a direct transfer from one retirement account to another (such as an IRA to IRA transfer), you won’t get any notification from your previous custodian in the form of a 1099-R. That’s because the transaction isn’t reported to the IRS. You are able to transfer funds between your retirement accounts as many times as you want, in your own desired time frame. There are no restrictions or limitations on transfers between IRA to IRA custodians.
Reporting an Indirect Rollover
You will need to document the indirect rollover on your tax return, as the IRS wants to see a paper trail of where your funds went. This also helps the IRS to determine if any taxes are due on your rollover.
On your personal income tax IRS Form 1040, input the indirect rollover amount in Box 16a. In Box 16b, you’ll note $0 rollover if you deposited your funds within the 60-day window.
If you’ve done an indirect rollover, your custodian will send you a form 1099-R documenting the amount that was distributed from your retirement plan. Any deviation of deposit from the amount listed on form 1099-R will be a taxable event.
With an indirect IRA rollover, you are only able to complete one per 12-month period.
Whether you do an indirect rollover, trustee-to-trustee transfer, or direct rollover, keeping good records is crucial. Whenever retirement accounts are involved, it’s vital you keep excellent track of when you submitted documentation, how funds were received, who the check was made payable to, who you spoke with at your old and new custodial firms, etc.